Welcome to the Property Imperative weekly to 16th June 2018, our digest of the latest finance and property news with a distinctively Australian flavour.
Watch the video, listen to the podcast, or read the transcript.
We start with the international markets, because familiar market foes returned this week as the U.S. and China vowed to move ahead with trade tariffs. China ignored U.S. President Donald Trump’s threat of further tariffs in the event of retaliation, vowing to immediately impose penalties of the “same scale” on American goods, raising the prospect of a tit-for-tat trade war between the world’s two largest economies.
The Fed rate hike on Wednesday was accompanied by a more hawkish outlook on rate hikes. The U.S. central bank hinted at the prospect of two additional rate hikes this year, taking the expected total rate hikes for 2018 to four from three previously. The odds of a fourth rate hike at the Fed’s December meeting has soared to 51.1% from 33.8% the previous week. While the prospect of a faster pace of US monetary policy tightening also weighed on sentiment, that didn’t stop US stocks from notching a third-straight weekly win as a rally in tech and media stocks underpinned investor demand. The VIX volatility index, which signals the relative uncertainty in the market, was down again, from its peak a few weeks ago.
The U.S. District Court ruled in favour of the AT&T and Time Warner merger earlier this week, sparking a wave of action in media stocks and a day after the ruling, Comcast launched a $65 billion bid for Twenty-First Century Fox assets that Walt Disney had already struck a deal to buy, setting the stage for perhaps an intense bidding war. The S&P 500 posted a weekly win despite closing 0.25% lower Friday at 2,781.50 reacting to the escalating trade wars.
Crude oil prices settled sharply lower on Friday on concerns that OPEC would lift limits on production restrictions, paving the way for an uptick in global output, threatening the pace of rebalancing in oil markets. Investor fears that OPEC and its allies would hike output at its June 22 meeting came to the fore this week amid remarks from both Russia’s and Saudi Arabia’s Energy Ministers. Both agreed to gradually increase production. Crude futures settled 2.74% lower on Friday as data showed U.S. oil rigs continued to climb.
The US dollar closed at year-to-date highs against its rivals despite a modest setback on Friday, as a sharp tumble in the euro earlier this week encouraged traders to pile into the greenback. The euro suffered its worst daily loss in two years on Thursday after the European Central Bank said that it would leave interest rates unchanged until the summer of 2019, although they will taper down QE through this year. That came a day after the Federal Reserve had signalled a faster pace of rate hikes for this year and the next, further encouraging investor appetite for the greenback. The dollar fell 0.16% to 94.79 against a basket of major currencies on Friday. The Aussie Dollar slipped against the US Dollar, which signals a risk of importing inflation into Australia and risks to the local economy.
Gold prices fell to 2018 lows on Friday as traders appeared to unwind their holdings of gold despite the growing prospect of a trade war between the U.S. and China. That, however, failed to lift demand for safe-haven gold amid expectations the dollar will continue its upside momentum.
And crypto currencies slid this week, wiping more than $60 billion from the market, as bitcoin fell to a near four-month low before staging a timid rebound. Bitcoin started the week on the back foot after South Korean crypto exchange Coinrail confirmed in a tweet that cyber thieves had made off with over $30 million worth of lesser-known cryptocurrencies following a successful cyberattack. That proved to be touch paper for further selloffs as the popular crypto fell close to a four-month low of $6,125.7, rattling traders’ appetite to hold cryptos as billions of dollars were pulled from the market.
The total crypto market cap fell to about $282 billion, from about $342 billion a week ago. Over the past seven days, Bitcoin fell 18.67%, Ethereum fell 14.04%, while Ripple XRP fell 19.29%. More evidence, if you needed it that crypto is not a stable currency alternative.
But risks lurk in the dark corners, according to Fitch Ratings. Global trade tensions have risen significantly this year, but at this stage they say the scale of tariffs imposed remains too small to materially affect the global growth outlook. A major escalation that entailed blanket across-the-board geographical tariffs on all trade flows between several major countries would be much more damaging.
In addition, populist political forces continue to create policy risk and increase the threat of rising tensions within the eurozone that could adversely affect the outlook for investment, a key driver of growth last year. Fitch made only a modest downward revision to their eurozone investment forecast for this year (to 3.3% from 3.9% in March), but a further escalation in uncertainty represents an important downside risk.
And a much sharper-than-anticipated pick-up in US inflation remains a key risk to the global outlook they said. The decline in US unemployment – to 3.8% in May – is becoming more important to watch, and they forecast the rate to hit a 66-year low of 3.4% in 2019. A wide array of indicators of US labour market tightness suggest it is now only a matter of time before sharper upward pressures on US wage growth start to be seen. They said that “An inflation shock in the US could bring forward adjustments in US and global bond yields and sharply increase volatility, harming risk appetite. In particular, it could lead to a rapid decompression of the term premium, which remains negative for US 10-year bond yields. In combination with a likely aggressive Fed response, this would be disruptive for global growth.
Indeed, the synchronised global economic growth that began in 2018 appears to be running its course, according to NAB. ‘Synchronised global growth’ was a favoured expression by economists and research houses at the end of last year, with each of the 45 major economies tracking upward growth.
But according to the latest economic summary by NAB this global growth rate may have reached its peak. Growth in the major economies was 2.2 per cent year-on-year in the first quarter of 2018, a small drop from the 2.4 per cent growth in the last quarter of 2017. “Although this slowdown was modest, it points to a divergence in conditions across countries, which over recent years have displayed relatively synchronised growth.” In addition, many short- and long-term interest rates have started to increase, or will do so over the forecast period”.
Turning to the local scene, Moody’s confirmed Australia’s rating of Aaa, which puts us in an exclusive club alongside United States, Switzerland, Sweden, Norway, Denmark, Netherlands and New Zealand. They just reviewed the rating (some other agencies still have a negative watch on Australia, as they are more concerned about the outlook, given our exposure to foreign trade and debt) but Moody’s concluded that thanks to good GDP numbers, relatively low (on an international basis) Government debt – at only 42% of GDP, though up from 26.5% five years ago and our strong institutions (RBA and APRA), the rating is confirmed. The bonus income from higher resources prices also helped. They did highlight some concerns about the Government needing to control spending in order to bring the budget back into balance as forecast, against a fraught political background and also the risks from high levels of household debt in a flat wage environment. They suggest that household income growth will be lower than government forecasts, but they are still looking for GDP growth around 2.75%. They also suggest that Government spending will remain under pressure given the expected 6% rise in social welfare programmes including health and NDIS. In terms of risks, they see two, first is rising household debt, which they say exposes the economy and government finances. Second is Australia’s reliance on overseas funding, which may be impacted by changes in international investor sentiment. Rate rises abroad might lift the cost of government and bank borrowing, adding extra pressure on the economy. But their judgement is these risks are not sufficient to dent the prized Aaa rating. So that’s OK then, except that…
S&P Global Ratings RMBS Performance Watch to 31st March 2018 said that the prime 30-day SPIN was 1.37% in Q1 2018, up from 1.07% the previous quarter. They say that loans more than 90 days in arrears were at a historically high level at the end of Q1, indicating that mortgage stress has increased for some borrowers. Western Australia meanwhile again recorded the nation’s highest arrears, at 2.71%. Arrears rose during Q1 in most parts of the country. And they warned of the consequences of higher interest rates ahead. You can grab our separate post “What the Rating Agencies Are Saying” for more details.
Our latest Household Financial Security Index showed a further fall dropping to 90.2, down from 91.7 last month. This is below the neutral setting of 100. Property-related sentiment is hitting hard, especially in New South Wales and Victoria where price falls are most evident. Younger households the budget pressure on them remains severe, especially those paying rent, or mortgages. Those entering the retirement phase, 60+ continue to wrestle with outstanding mortgages (many hold these loans into retirement now) and also lower returns from deposits. You can get the full results in our post “Household Financial Security Tanks In May, As Property Falls Hit Home”.
It’s worth putting this alongside the RBA comments this week on wages growth, which suggests that any lift from the current anaemic levels will be slow. And real debt burdens will stay higher for longer in this scenario. Many people who borrowed expected their incomes to grow at something like the old rate rather than the current rate. With their expectations not being realised, the real value of the debt stays higher than they expected and this is likely to affect their spending decisions. And beyond these purely economic effects, the slow wages growth is diminishing our sense of shared prosperity. If this remains the case, it can make needed economic reforms more difficult.
Oh, and the employment data out this week superficially looked OK, with an increase in the total number of jobs, and a fall in the seasonally adjusted rate of employment from 5.6% last month to 5.4% in May. But in fact we think this is another soft result, thanks to a slide in the number of hours worked, anaemic and falling jobs growth, a further shift to part time employment, and a rise in underemployment. The monthly trend unemployment rate remained steady at 5.5 per cent, well above the 5% level at which wage rises may kick in according to the bank. See more at our post “Unemployment Signals More Trouble Ahead”. The trend participation rate decreased by less than 0.1 per cent to 65.5 per cent in May 2018.
The auction results last week were down again but hardly worth a mention, given the long weekend in many states. But the trend of slowing property continues to bite harder. CoreLogic once again have been looking at where prices are falling. They say that across the combined capital cities, dwelling values have fallen 1.1% over the past 12 months. Looking at the 1st decile, values have increased by 1.3% over the past year while across the 10th decile values have fallen by -5.7%. Of note is that when values fall, declines across the most affordable properties have been significantly smaller than the declines across the most expensive properties. The opposite is generally the case during the growth phase, where the most expensive properties have generally outperformed the broader market.
Sydney has seen the largest declines of all capital cities over the past year with values -4.2% lower. Across the 1st decile, values are 1.0% higher while the 10th decile has recorded value falls of 7.3%. Over the past year, Melbourne dwelling values have increased by 2.2% with the 1st decile recording an increase of 10.3% while the 10th decile has seen value fall -3.5%.
This makes it clear that you need to get granular across the property market, something which we discussed in our interview with Buyers Agent Chris Curtis, last week. The full interview “Property Dispatches from The Front Line” is still available and I recommend it. This post hit top spot on both our blog and YouTube sites. It seems that first time buyers are helping to support the market, though the latest figures show that total number of first time buyer loans in May fell by 8%.
Indeed, overall lending growth is slowing as the ABS data this week showed. They confirm the macro trends we already reported. Lending volume flows are solidly down, and the trends suggest more in the months ahead. We are entering a new phase in the credit cycle, and this will put further pressure on home prices. You can get more from our post “Yet More Evidence Of The Property Slowdown”
Finally, as the AFR pointed out, the banks are under intense margin pressure now as they are being squeezed by higher borrowing costs as the US Federal Reserve accelerates its interest rate hikes and drains liquidity from global financial markets while the Hayne royal commission makes it difficult for them to raise home loan rates. They said that analysts estimated that the spreads paid by Australian banks have climbed by close to 40 basis points since the beginning of the year, which has swollen the wholesale borrowing costs of the country’s banks by some $4.4 billion a year. They quoted AMP’s head of investment strategy, Shane Oliver, who said the blowout in the BBSW could reflect Australian borrowers rushing to lock in funding before the end of the financial year, for fear that the borrowing situation could worsen. Dr Oliver said the banks were likely to be absorbing the higher funding costs in their margins. But, he warned, the “risk is that they will start to increase some mortgage rates”.
But we think something else is going on, because the spreads in Australia are a lot bigger now than other markets, and we suspect it’s a lack of confidence in our local banks, thanks to the revelations from the Royal Commission. A quick look at the recent share prices of for example Westpac, the largest investment loan lender, and CBA the largest owner occupied loan lender tells the story. The markets are nervous. The pincer movements of higher funding, less confidence and a slowing and more risky housing market are all adding to the banks’ woes. They are stuck because any lift in mortgage rates will drive prices lower and lift defaults from overleveraged households. Actually this is the reason why we think the RBA may be forced to cut the cash rate ahead. A nasty cocktail.
